Will’s Winery is considering replacing equipment in its winery near campus. The

Question

Will’s Winery is considering replacing equipment in its winery near campus. The new equipment will cost $270. Shipping of the new equipment will cost $60 and installation of the equipment will be $50. The old equipment has been in service for three years and has a depreciable basis of $200. The building will need modifications costing $100, but these will be paid by the landlord. The modifications, new equipment, and old equipment are depreciated using the 5-year MACRS schedule.   Will’s Winery will operate the winery for four years and then expects to sell the winery to an investor. We think the winery will sell for $600 plus any working capital, whether or not we buy the new equipment. To operate the winery, Will’s Winery will need an increase in Inventory of $27, an increase of Accounts Receivables of $14, and will have an increase in Accounts Payable of $19. Working capital will be recovered when we sell the winery.

Annual sales will increase will increase from $2000 to $2500, if we install the new equipment. Our current Cost of Goods Sold (excluding overhead, depreciation, and lease payments) is 50% of annual sales, and will remain at at 50%. To operate the equipment, operators must be hired at an annual fixed cost of $45.

Will’s has an agreement for a 3-year 6% amortized Small Business Administration Loan to finance the new equipment. Our outside auditor is raising his annual fee from $20 per year to $25 per year. The firm’s tax rate is 30%. The cost of capital is 13%.

What are the total Initial Cash Flows in Year 0?

What are the total Operating Cash Flows in Year 2?

What are the total Terminal Cash Flows in Year 4? (I want only Terminal Cash Flows, not operating cash flows in year 4)

Explanation / Answer

Year 0   cash flows Cost of new equipment(270+60+50)= -380 Increase in Net working capital(27+14-19)= -22 Total Initial   Year 0 cash flows -402 Annual payment on total value of the loan will be 380=Pmt*(1-1.06^-3)/0.06 pmt.= 142.16 Loan amortisation schedule Year Annuity Tow. Int. Tow. Princ. Prin. Bal. 0 380 1 142 23 119 261 2 142 16 127 134 3 142 8 134 0 Year 2 cash flows: Sales 2500 Less: COGS -1250 Less:Hiring charges -45 Less: int. on loan -16 Less:Auditor fee -25 Les: MACRS depn.32%*380 -122 EBT 1042 Tax at 30% -313 EAT 730 Add back: depn. 122 Operating cash flow 852 Less: Loan principal repayment -127 Net cash flows for Year 2 725 Year 4 cash flows Recovery of net working capital 22

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